Fed Policy: Good Intentions, Risky Consequences

September 30, 2013

Some of the actions the Federal Reserve has taken to address the financial crisis and the slow economic recovery, while well intentioned, have created some long-term risks for the economy and for the Fed as an institution. Excessive focus on the short term can result in long-term problems. Avoiding these risks is dependent on the Fed executing a graceful exit from this period of extraordinary accommodation. Such an exit depends on the Fed's ability to be systematic and transparent about its policy decisions, says Charles I. Plosser, president and chief executive officer of the Federal Reserve Bank of Philadelphia.

Four monetary policy principles that Plosser suggests:

The first principle is to be clear and explicit about the goals and objectives of policy. And in so doing, policymakers must acknowledge what policy can and cannot achieve.

The second principle is for policymakers to make a credible commitment to their goals by describing how they will conduct policy in a way that is consistent with those goals. One way to do this is for the central bank to articulate a reaction function or rule that will guide policy decisions.

The third principle is to be clear and transparent in communicating to the public the policy actions that are taken.

The fourth principle is to strive to ensure central bank independence.

Over the past several years, the Fed has taken some beneficial steps toward increased transparency, which will serve the economy well now and in the future. The Fed should continue on this path by more clearly articulating a systematic approach to policymaking, centered on using robust simple rules as guides to both its policy decisions and the way in which it communicates those decisions.